Markets declined steadily through most of March, and the S&P 500’s 2.6 percent decline for the quarter was its greatest in two years. When markets approached their January lows this week, many investors were concerned that if we broke through those levels a broader decline could ensue. Should investors stay bullish after what has been a rough year so far? There are reasons to think equity performance will pick up in the coming weeks.
The economy appears to be strong overall, yet still not overheating.
In the last few weeks inflation concerns have risen as have worries that the Fed would become more aggressive in raising rates. However, this week much of the economic news mirrored 2004’s story: the economy is growing, but a modest and unworrisome pace.
GDP growth came in at 3.8 percent in the first quarter, less than expected. Durable Goods orders rose 0.3 percent, well below an expected 0.9 rise.
Friday’s Jobs Report was the most surprising. On average analysts expected the economy to produce 210,000 jobs, but it only produced 110,000.
How much of the relatively poor economic data is due to high oil prices? It is hard to say, but oil prices that stubbornly remain above $50 per barrel have the potential to reduce discretionary consumer spending. Interest rates have declined since Wednesday as a result of these less than stellar economic reports.
The yield on the 10-year Treasury had risen to nearly 4.65 percent early this week, but with today’s reports it has fallen below 4.5 percent.
Investors were very concerned that the FOMC would raise rates by 50 basis points at one of its next two meetings, but now they are having to back off those expectations.
A look at the market’s technicals yields a mixed picture.
On a short-term basis stocks appear oversold, and thus this week’s bounce off of major support levels has not been surprising.
Longer-term technical up trends remain intact, but new lows still exceed new highs on the NYSE and NASDAQ.
Markets have traded sideways and even slightly down since 2004’s fourth quarter rally.
Many bullish longer-term indicators are in danger of turning bearish if markets do not break out of their trading range.
In late 2004 as stocks enjoyed a fourth quarter rally sentiment readings showed extreme optimism, and since then stocks have declined. After three months of weakness in equities, investor sentiment has turned around and now readings are close to extreme pessimism. Investors Intelligence’s survey now shows the highest percentage of bears since August 2004, the last major market low.
This reading combined with technicals that show the market is short-term oversold make a strong case for holding onto stocks despite the recent turbulence.
Normally when equities reach oversold levels they may move sideways for a while as a base building process begins.
Only then will equities begin a substantial rally. We believe that base building process is occurring right now and look at any short-term weakness that may occur as a buying opportunity.
Weakness in the high yield market persists, as there is a dearth of good news that would cause any kind of reversal.
Thursday’s buying spree in the stock market — usually a positive influence on high yields — did little to spurn the broad pessimism engulfing the credit arena.
General Motor’s woes are the prime engine for the current sentiment. To put it into perspective, according to Bloomberg, credit derivatives that limit losses for holders of carmaker Fiat’s debt in case of bankruptcy is cheaper than that of GM. This is evident even though Fiat’s debt is rated three levels below GM’s bonds.
Anomalies such as this are sure signs that investors have little hope that the world’s largest carmaker will retain the prized investment grade designation.
Aside from these credit concerns, rising interest rates are the other driver of high yield weakness. Greenspan’s march towards an “appropriate” federal funds rate has begun to take its toll on bonds. This tightening environment would be less damaging if the market can prove that rising rates are not solely the Fed’s response to rising commodity prices but also a result of a strengthening labor market, high productivity, and robust corporate profits.
Jason M. Duhon, MBA is a local financial advisor (435-830-9714 or 800-482- 9714) and OSJ manager with SunAmerica Securities. The information contained in this column is NOT a recommendation and is to be used for informational purposes only. Please consult a qualified financial advisor to see if this strategy meets the needs of your specific situation.